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Japanese equities – the new safe haven

For fund managers, the answer is simple: according to the Expert Investor Fund Manager Survey, there is a strong consensus that Japanese equities will be the best performing asset class in 2017. 

At first sight, the stars indeed look aligned for Japan. The Bank of Japan (BOJ) is providing a powerful back-stop in the form of continued buying of government bonds as well as equities, while it has promised to anchor the 10-year government bond yield at 0%. Since April 2016, the BOJ has bought Japanese equity ETFs worth more than ¥4trn (€33bn). 

Donald Trump’s expected fiscal spending could also benefit Japanese equities. A boost to US GDP growth would directly benefit Japanese companies as it would power demand for their products: 20% of the country’s exports go to the US (compared to some 18% of China’s exports). Though Trump’s trade policies are yet unknown, it looks unlikely that Japan will be among his first targets.  

“While it is too early to say what the incoming US president will do, it would appear that the US-Japan relationship will be satisfactory. Prime Minister Abe was the first foreign leader to meet President-elect Trump one-on-one,” notes Naoki Kamiyama, Chief Strategist at Nikko AM.

Doubts remain

So have investors started to put money into the asset class already? The latest European fund flows data available date back to November, and these suggest change is underway: net inflows into the asset class were the highest since July 2015, at €938m, following 10 months of consecutive net outflows.

It’s not at all certain that these flows will persist though: most fund buyers remain agnostic about Japanese equities, as the asset class remains haunted by its capricious long-term track record. Though interest has ticked up slightly in recent months, the majority of investors plan to keep their allocations to Japanese equities stable over the next 12 months. 

There are indeed reasons to remain sceptical. The fortunes of Japanese equities have been highly dependent on the dollar/yen exchange rate in recent years, whereas a weak yen translates in stock market gains while the opposite happens when the yen strengthens. The post-Trump rally has only been the latest example of this: since November, the dollar has risen by 11% against the yen, while the Topix index has posted a gain of some 13% in local currency terms. 

But there is another element to Japanese equity performance: the Topix index has closely tracked the MSCI World Index over the past three years (see chart at the top). This suggests Japanese equities are highly sensitive to the global business cycle. The asset class could therefore profit disproportionally from an uptick in global growth. 2017 could therefore indeed be the year Japanese equities will finally deliver.    

 

Part of the Bonhill Group.